Dancing with danger

FOR the second time in as many weeks, President Nicolas Sarkozy flew to Paris for the day from his holiday spot on France's Mediterranean coast to try to calm the markets. His meeting with the German chancellor, Angela Merkel, at the Elysée Palace on August 16th took place as the panic of recent weeks had given way to mere gloom about the stagnating euro-zone economy. But France itself remains under close scrutiny, after dramatic drops in the share prices of some French banks last week (see article) and rumours that the country might lose its cherished AAA credit rating. Just eight months before an uncertain presidential election, and with a tough 2012 budget to finalise, Mr Sarkozy faces the delicate task of squaring his electoral needs with the concerns of investors.

At their meeting the leaders of the euro zone's two biggest economies came up with only timid ideas. They proposed that heads of government of the 17 countries that use the currency should meet twice a year, a first step to institutionalising the “economic government” of the euro so craved by Mr Sarkozy. They suggested that all members introduce “golden rules”: constitutional clauses limiting budget deficits. (Germany already has one, Italy has pledged to introduce one and Mr Sarkozy wants one for France.) There was more talk of tax harmonisation, better budget co-ordination and a tax on financial transactions. But the pair ruled out any immediate plans for Eurobonds—“one day, perhaps”, mused Mr Sarkozy—and rejected any enlargement of the euro zone's bail-out fund.

It was one thing to try to hold the euro together from a position of relative strength in the core. But growth is now faltering in both Germany and France, which together account for half of euro-zone GDP. Figures this week showed that Germany's quarterly economic growth slowed in the second quarter of 2011 to 0.1% of GDP. France failed to grow at all.

Of the six AAA-rated countries in the euro zone, France looks the shakiest (see chart). But some of last week's market nervousness still seems overdone. Spreads—the premium that investors demand to hold French debt over benchmark German bonds—have widened since July, but are way off Spanish or Italian levels. Each of the big three credit-ratings agencies reaffirmed France's AAA status last week, and none has said it expects an imminent downgrade. The public finances may not be in great shape, but they are hardly the worst in the rich world. French public debt is expected to reach 85% of GDP this year, according to European Commission forecasts: slightly more than in Germany (82%), but less than in Italy (120%) or the United States (98%). The budget deficit, forecast at 5.8% of GDP in 2011, is closer to Greece's (9.5%) than to Germany's (2%), but it has been steadily falling. Mr Sarkozy has promised to squeeze it to 3% by 2013. “The fundamentals for the French public finances look solid,” argues a research note from Credit Suisse.

So why the nagging market worries? One reason is the deteriorating economic outlook. French consumer spending, the motor of expansion over the past decade, is faltering. Sluggish growth in Germany, France's biggest trading partner, and the rest of the euro zone is taking its toll. And France is sorely exposed to the euro zone's troubled debtors. Its banks hold more Italian, Spanish and Greek debt than banks in any other country outside the periphery. Recent jitters over Italy and Spain have raised fears over France's ability to meet its share of any new bail-out commitments.

Slow growth will, in turn, make it harder for France to meet its deficit targets. Mindful of this, Mr Sarkozy has asked François Baroin, the finance minister, and Valérie Pécresse, the budget minister, to draw up a list of extra budget savings for 2012, ahead of a cabinet meeting on August 24th. There is talk of yet more pruning of tax exemptions, and possibly a new tax on “extravagant” incomes—though not, lamentably, of reversing a daft reduction in value-added tax for restaurants that costs the state €2.4 billion ($3.5 billion) a year. Without some savings, says Laurence Boone at Bank of America Merrill Lynch, France will not meet its 3% deficit target until 2014, a year later than planned. Last month the IMF warned France that its growth forecasts were over-optimistic and that it would need “further measures”, particularly spending cuts, to stay on track. Ms Boone reckons they may need to be worth €20 billion over the next two years.

This is where the real trouble lies. Mr Sarkozy's tinkering—not replacing one in two retiring civil servants; trimming tax exemptions—has allowed him to keep his deficit-reduction promises, so far. Yet besides last year's lifting of the minimum retirement age from 60 years to 62, he has done little to reform public spending structurally. As a share of GDP, the French state now spends more than Sweden. This is not only the result of recession: France's national auditor calculates that crisis-related measures accounted for less than half of last year's deficit. Moreover, the country's long-term track record is dismal. No French government has balanced a budget since the early 1970s. Governments of all stripes have let debt pile up for future generations, preferring to blame speculators and ratings agencies for problems of their own making.

To add to the uncertainty, France faces a presidential election next spring. With his poll numbers at last beginning to rise from record lows, Mr Sarkozy is in no mood to make unpopular spending cuts. But the prospect of a Socialist victory is hardly reassuring, given the party's pledges to reverse Mr Sarkozy's rise in the retirement age and to create a mass youth public-employment scheme.

Some Socialist presidential hopefuls, who will contest a primary in October, have begun to talk more responsibly about debt. This week François Hollande, the poll favourite, described public debt as “France's enemy”. But the party is against Mr Sarkozy's plans to write a golden rule into the constitution, for which he will need a three-fifths majority in both houses of parliament. They see it as a gimmick to mask the rise in debt on his watch, and the last thing they want is to hand Mr Sarkozy any sort of political success. But, as America has found recently, the last thing investors like is any sign of political failure.